Under most tax-qualified retirement plans, such as 401(k) plans, upon the termination of an employee's participation in the plan, the plan administrator must automatically distribute the participant's account balance if it is $5,000 or less. If the participant does not make an affirmative election (e.g., to elect a rollover to another tax-qualified plan or an individual retirement account ("IRA")), the entire account balance must be distributed to the participant. Under current law, 80% of the participant's account is distributed directly to the participant and 20% is remitted to the IRS as required withholding tax. The distribution may also be subject to a 10% early withdrawal penalty.
Under the Economic Growth and Tax Relief Reconciliation Act of 2001, if a plan participant with an account balance greater than $1,000 but less than or equal to $5,000 fails to make an affirmative election, the plan administrator must roll over the distribution to an IRA it establishes for the participant. This new requirement was to become effective when the Department of Labor ("DOL") regulation governing such mandatory rollovers became final. The DOL only recently issued final regulations setting forth a safe harbor for plan administrators under which plan administrators are deemed to have satisfied their fiduciary duties with respect to the selection of IRA providers and the funds held in the IRA, provided the requirements for the safe harbor are met.
The requirements for the safe harbor in the DOL regulation are as follows:
The amount rolled over to the IRA must not exceed the amount that can be distributed without the participant’s consent (i.e., $5,000).
The rollover must be made to an IRA or an individual retirement annuity.
The plan sponsor and the IRA trustee or custodian must enter into a written agreement that specifically provides for the investment of the rollover funds only in certain stable value products (e.g., money market funds, interest-bearing savings accounts, and certificates of deposit) and for fees and expenses that are comparable to charges for other IRAs that are not automatic rollover IRAs.
The plan administrator must provide to plan participants, as part of the summary plan description ("SPD") or in a summary of material modifications, a description of the plan's automatic rollover provisions; the description must include an explanation of the required investment procedures, a statement indicating how the IRA's fees and expenses will be allocated, and contact information for further information concerning the plan's automatic rollover provisions, the IRA provider, fees, and expenses.
The final regulations are effective for cash-out distributions made on or after March 28, 2005. In advance of the March 28 deadline, plan administrators will need to select one or more IRA providers and enter into agreement(s) with the IRA provider(s) in order to be in compliance with the new rule. Plan documents will also need to be amended and SPDs revised accordingly.